{"id":206,"date":"2008-10-04T22:32:00","date_gmt":"2008-10-04T22:32:00","guid":{"rendered":"http:\/\/www.dresan.com\/blog\/?p=206"},"modified":"2017-04-08T21:11:51","modified_gmt":"2017-04-09T04:11:51","slug":"political-diary-the-bailout","status":"publish","type":"post","link":"https:\/\/dresan.com\/blog\/2008\/10\/04\/political-diary-the-bailout\/","title":{"rendered":"Political Diary: The Bailout"},"content":{"rendered":"

So the bailout of the financial system passed this week.\u00a0 And I breathed a sigh of relief, sort of, and wondered what I would have done if that was my decision to make.\u00a0 I’m torn by two conflicting feelings: first, that we cannot afford to let the financial system collapse, and second, that we cannot afford to throw good money after bad.<\/p>\n

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Sometimes, of course, we have to let things die.\u00a0 But the overall financial system is not one of them.\u00a0 Financial instability is a vicious cycle: once the system becomes unstable, investors become afraid to invest money, making it hard for people and businesses to get money, causing more failures and instability.\u00a0 Put another way, Main Street depends on the jobs provided by businesses that depend on Wall Street’s ability to lend money.<\/p>\n

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As I understand it, currently many businesses large and small depend on short-term loans for everything from operating capital to pay for stock in their warehouses to emergency funds to pay for the roof busted in last month’s storm.\u00a0 They get this money from banks, who in turn get that money from you and me; they pay these loans back with interest, which the banks shave off as their cut before paying you and me our interest.<\/p>\n

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But banks right now are afraid to lend money, because so many banks, funds and businesses have recently collapsed.\u00a0 On paper, the banks have enough assets to loan out, just the same way as the average American with a decent-priced home has enough assets to buy a Lamborghini.\u00a0 However, most Americans can’t<\/em> buy a Lamborghini at the drop of a hat, even if they wanted to, because their wealth is tied up in longterm IRAs or CDs or in stocks which have dropped or homes with heavy mortgages.\u00a0 SO on paper you have the money to spend on a midlife crisismobile, but in practice you don’t.<\/p>\n

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\u00a0The technical term for this is illiquidity<\/em>, which is just a fancy way of saying that have wealth on paper, but can’t turn it into money without incurring terrible losses.\u00a0 A lot of banks are in precisely this situation: they want to loan money to a potential new homeowner or to a businessman trying to repair his roof, but their money is all tied up in investments they can’t move without losing big — in this case, mortgage-backed securities.<\/p>\n

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These "mortgage backed securities" arose because over the past several years housing prices were going up and up, and the government encouraged banks to make loans to people who traditionally were at higher risk than normal.\u00a0 These so-called subprime mortgages were packaged up into "investment vehicles" and "sold off"\u00a0 — essentially meaning the banks that made the loans sold the rights to the interest that the mortgages would make to other people.\u00a0 That was a good deal while the economy was great because people were paying their mortgages or trading up to better homes.\u00a0 Then the economy started to stall and the housing bubble burst … and suddenly people aren’t making those payments.<\/p>\n

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This led to a "liquidity crisis" which is just another big fancy word for "runs on the banks".\u00a0 Perfectly good banks with great track records and billions of dollars on their books that hit a few rocky patches suddenly saw their money dry up in a number of weeks, leaving them with large short-term debts which in theory they could easily pay off … except they couldn’t move their mortage-backed securities.\u00a0 One bank failed after the other and in the end banks got afraid to loan money to anyone.<\/p>\n

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So the point of the bailout: those mortgage backed securities are not actually worthless<\/em>.\u00a0 If the economy gets back on its feet (which, eventually, it almost certainly will) and home prices start to rise again (which, eventually, they almost certainly will), some huge percentage of those securities will pay off.\u00a0 It’s just a long waiting game, a game which banks can’t play because they’re constantly lending and spending, but which the government can play, because of its deeper pocketbooks and constant source of real income from taxpayers.\u00a0\u00a0 So the theory behind the bailout is, the government will buy those illiquid securities, allowing Wall Street to start lending money again, so business owners can stay in business, and Main Street can keep its jobs.<\/p>\n

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Which goes to my second concern, throwing good money after bad.\u00a0 Our civilization has experienced Dark Ages.\u00a0 Our country has experienced a Great Depression.\u00a0 What if we go through ten or twenty years of economic depression, and most of those mortgage backed securities are essentially worthless?\u00a0 That’s over two thousand dollars out of the pocket of every taxpayer, another $700B on top of our $10T debt.\u00a0 Or, worse, what if the problems in our economic system are more systemic, and other banks are about to fail for other reasons?\u00a0 We might need that $700B for something else.<\/p>\n

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So, as I understand it<\/em>, the bailout is needed.\u00a0 But, as I understand it<\/em>, the bailout is risky.\u00a0 So what would I do if I was in charge?\u00a0 Well, here are a few rough ideas:<\/p>\n

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